ETF Options Strategies: Neutral Calendar Spread Explained

Exchange-traded funds (“ETFs”) provide an easy way for investors to gain access to nearly any country or asset class. In addition to providing diversified exposure in a single U.S.-traded security, ETFs are equities themselves that may have options available to trade. These options open up the door for investors to create additional highly targeted strategies [see also ETF Call And Put Options Explained].

In this article, we’ll look at the neutral calendar spread strategy and explore how ETF investors can use it to capitalize on sideways trading.

What Is a Neutral Calendar Spread Strategy?

Suppose an investor owns a commodity ETF that he or she uses to diversify an otherwise equity-heavy portfolio. Since the ETF is being used as a hedge, the investor may not be particularly bullish on the commodity ETF’s prospects. In this case, the investor could employ a neutral calendar spread in order to generate income from this sideways trading.

The investor would simply sell one near-term at-the-money call and buy one long-term at-the-money call option to create the neutral calendar spread. The resulting position takes advantage of the short-term option’s time decay, with the maximum losses limited to the debit taken to enter into the position, making it a relatively safe and predictable strategy [see Covered Call ETF Options Strategy Explained].

The resulting option diagram look like this:

Who Is the Neutral Calendar Spread Strategy Right For?

The neutral calendar spread strategy is perfect for investors that have a neutral outlook on a given ETF, which can occur for a variety of different reasons. In the example above, the investor was holding the ETF as a hedge and may not be expecting it to rise or fall in the near-term. But, other examples could include any other ETF that lacks a catalyst or is trading sideways [see also How To Hedge With ETFs].

The strategy works best in neutral markets, where the underlying stock price remains unchanged upon expiration of the near-term call option. The ideal market for this strategy would have very little in the way of near-term fundamental catalysts and would be exhibiting sideways trading patterns when using technical analysis (e.g. within a defined price channel).

What Are the Risks/Rewards?

The neutral calendar spread strategy has a very well defined risk to reward profile. Profit potential is limited to the premiums collected from the sale of the near-term call option minus any time decay of the long-term call option. Meanwhile, downside risks are limited to the initial debit taken to enter into the position, which goes into effect when the stock price declines [see also How To Take Profits And Cut Losses When Trading ETFs].

The maximum profit and loss scenarios are:

Maximum Profit occurs when the underlying stock remains unchanged upon expiration of the near-term month option.

Maximum Loss occurs when the underlying stock falls and stays lower until expiration of the long-term month option.

How to Use a Neutral Calendar Spread Strategy

Suppose that an investor owns 100 shares of the SPDR Gold Trust ETF (GLD, A-) and believes that it will trade sideways over the coming three months. So, he or she decides to use the neutral calendar spread strategy and sell/write one near-term at-the-money JUN 140 call for $4.83 and buy one long-term at-the-money AUG 140 call for $6.05 for a net debit of $122 to enter the position.

There are three basic scenarios that could then play out:

GLD Price at Expiration

Profit/Loss

<140

$483

=140

$483

<160

$483 – $605= -$122

Below 140.00. If the stock price falls below $140 in June, the investor would realize the $483 gain from writing the call option, offset by the time decay and price depreciation on the August call option that’s owned.

At 140.00. If the stock is at $140 in June, the investor would realize the $483 gain from writing the call option, offset by just the modest time decay on the owned call option.

Above 140.00. If the stock is above $140 in June, the investor would liquidate their stock position to cover the written call (or cover it at a loss), offset by the difference between time decay and appreciation on the August owned call option.

The key decisions that need to be made are often when the near-term option expires. At this point, the investor can either write another near-term call option to replace it, hold the long-term call option to profit from upside movements, or cover the position at a profit or loss. Some of this decision will depend on future volatility, with higher volatility making the long-term call option profitable and low volatility making a written short-term call option most preferable [see also ETF Protective Put Options Strategy Explained].

The Bottom Line

Investors that wish to capitalize on sideways price movements can use neutral calendar spread strategies to do so. By selling one short-term at-the-money call option and writing one long-term at-the-money call option, these investors can capitalize on the short-term option’s time decay that will lose value more rapidly than the offsetting long-term call option.

Often, neutral calendar spreads can be used without any underlying stock, but ETF investors may find it most useful to help generate an income from a hedge or other necessary position held during a sideways market. Either way, the strategy is a useful tool to have available in any trader’s repertoire.

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